Hedge accounting recognizes is used to recognize the offsetting effects on profit or loss of changes in the fair values of the hedging instrument and the hedged item. Hedge accounting is applied if the following conditions are fulfilled:

at the inception of the hedge there is formal designation and documentation of the hedging relationship and the risk management objective and strategy for undertaking the hedge. The documentation includes identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the entity will assess the hedging instrument’s effectiveness;

the hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows, consistently with the originally documented risk management strategy for that particular hedging relationship;

in the case of cash flows it is highly probable that a hedged transaction occurs that is exposed to changes in cash flows affecting the profit and loss account;

the effectiveness of the hedge can be reliably measured, i.e. the cash flows of the hedged item and the fair value of the hedging instrument can be reliably measured;

The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated.

33.5.2 Types of hedging strategies

33.5.2.1 Fair value hedges

Changes in the fair value measurement of financial instruments designated as hedged items are recognized, in the part related to the hedged risk, in the profit and loss account. The remaining part of changes in the carrying amount are recognized in accordance with the general rules applicable to a given class of financial instruments.

Changes in the fair value measurement of derivatives designated as hedges in hedge accounting are recognized in full in profit and loss, in the same line item where the effect of changes in the measurement of the hedged item are recognized.

The PZU Group ceases to apply hedge accounting if the hedging instrument expires or is sold, terminated or exercised (for this purpose, the replacement or rollover of a hedging instrument into another hedging instrument is not an expiration or termination if such replacement or rollover is part of the hedging strategy), if the hedge no longer meets the hedge accounting criteria or the hedging designation is revoked.

Adjustment for hedged risk on the hedged interest item is amortized to profit and loss no later than at the moment when hedge accounting is discontinued.

33.5.2.2 Cash flow hedges

Cash flow hedge is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognized asset or liability or a highly probable planned transaction and could affect profit or loss.

The result of measurement of the effective part of cash flow hedges is recognized in other comprehensive income. The ineffective part of the hedge is recognized in profit or loss.

33.5.3 Description of hedging designations

Description of hedging relationship

Hedged item

Hedging instruments

Recognition in financial statements

Period in which cash flows are expected

1. Cash flow hedge for variable-rate loans

Alior Bank hedges the risk of a decrease in its net interest income in a low interest rate scenario in PLN by selling an IRS transaction based on the WIBOR rate.

The hedged item consists of loans granted to customers in PLN, where interest payments are based on WIBOR.

The hedging position consists of IRS transactions in PLN (long position at a fixed rate) under which Alior Bank receives fixed interest flows and pays variable interest. The maturity of the hedging transactions corresponds to the maturities of the loans included in the hedged item.

The effective part of the change in fair value measurement of the hedging transactions is recognized in the revaluation reserve. The ineffective part of the change in fair value measurement of the hedging transactions is presented in the result on financial instruments held for trading. The interest on IRS transactions and on the hedged loans is recognized in net interest income.

The hedged item is expected to generate cash flows in the period until 15 December 2021.

2. Cash flow hedge for variable-coupon debt securities

Alior Bank hedges the risk of a decrease in its net interest income in a higher interest rate scenario in PLN by buying an IRS transaction based on the WIBOR 6M rate.

The hedged item consists of subordinated bonds issued by Alior Bank in PLN, under which interest payments are based on the WIBOR 6M rate.

The hedging position consists of IRS transactions in PLN (short position at a fixed rate) under which Alior Bank receives variable interest flows and pays fixed interest. The maturity of the hedging transactions corresponds to the maturities of the bonds included in the hedged item.

The effective part of the change in fair value measurement of the hedging transactions is recognized in the revaluation reserve. The ineffective part of the change in fair value measurement of the hedging transactions is presented in the result on financial instruments held for trading. The interest on IRS transactions and on the hedged bonds is recognized in net interest income.

The hedged item is expected to generate cash flows in the period until 26 September 2024.

3. Fair value hedge of fixed-coupon debt securities

Pekao hedges some of its interest rate risk arising from changes in the fair value of the hedged item caused by volatility of market swap interest rates through IRS transactions.

The hedged item consists of fixed- coupon debt securities classified as available for sale and denominated in PLN, EUR and USD.

The hedging position consists of IRS transactions in PLN, EUR and USD (short position at a fixed rate) under which Pekao receives variable cash flows and pays fixed interest.

The result on fair value measurement of the hedged items, related to the hedged part of the risk, is recognized in result on fair value hedge accounting. The remaining part of the fair value change (resulting from the spread between the swap curve and the bond curve) is recognized on general terms applicable to AFS instruments (i e. in revaluation reserve). Interest on the debt securities are recognized in net interest income. The change in fair value measurement of derivatives subject to fair value hedge accounting is presented in the result on fair value hedge accounting. Interest on derivatives subject to fair value hedge accounting is recognized in net interest income.

The hedged item is expected to generate cash flows in the period up to 18 January 2036.

Description of hedging relationship

Hedged item

Hedging instruments

Recognition in financial statements

Period in which cash flows are expected

4. Cash flow hedge for variable-rate loans and deposits

Pekao hedges part of its interest rate risk and FX risk arising from the variability of cash flows from variable-rate assets and liabilities through CIRS (basis swap) transactions.

The hedged item consists of two separate components, which are cash flows from a variable-rate asset portfolio and a variable- rate liability portfolio.

The hedging position is the portfolio of CIRS (basis swap) transactions, under which the Group pays variable-rate flows in foreign currencies and receives variable-rate cash flows in PLN/foreign currencies. CIRS transactions are decomposed into a component hedging the asset portfolio and a component hedging the liability portfolio.

The effective part of the change in fair value measurement of the hedging transactions is recognized in the revaluation reserve. The ineffective part of the change in fair value measurement of the hedging transactions is presented in the result on financial instruments held for trading. The interest on CIRS transactions and on the hedged items is recognized in net interest income.

The hedged item is expected to generate cash flows in the period up to 15 May 2029.

5. Cash flow hedge for variable-rate financial assets

Pekao hedges part of its interest rate risk arising from the variability of cash flows from variable- rate assets through IRS transactions.

The hedged item are cash flows from a variable- rate asset portfolio.

The hedging position is the portfolio of IRS transactions (short position at a variable rate), under which the Group receives fixed flows and pays variable flows.

The effective part of the change in fair value measurement of the hedging transactions is recognized in the revaluation reserve. The ineffective part of the change in fair value measurement of the hedging transactions is presented in the result on financial instruments held for trading. The interest on IRS transactions and on the hedged items is recognized in net interest income.

The hedged item is expected to generate cash flows in the period up to 29 April 2020.

The hedged item consists of variable-rate loans denominated in euro and US dollars.

The hedging position consists of the portfolio of fx-swap transactions.

The effective part of the change in fair value measurement of the hedging transactions is recognized in the revaluation reserve. The ineffective part of the change in fair value measurement of the hedging transactions is presented in the result on financial instruments held for trading. The settled portion of swap points on the hedging instrument is transferred from revaluation reserve and recognized in net interest income. The currency revaluation of the first exchange of capital for the hedging instrument is transferred from revaluation reserve and recognized in foreign exchange differences in the profit and loss account.

The hedged item is expected to generate cash flows in the period up to 12 October 2018.

Description of hedging relationship

Hedged item

Hedging instruments

Recognition in financial statements

Period in which cash flows are expected

7. Fair value hedge of fixed-coupon debt securities

Pekao hedges some of its interest rate risk arising from changes in the fair value of the hedged item caused by volatility of market swap interest rates through IRS transactions.

The hedging position consists of IRS transactions in PLN (short position at a fixed rate) under which the Group receives variable cash flows and pays fixed interest.

The result on fair value measurement of the hedged items, related to the hedged part of the risk, is recognized in result on fair value hedge accounting. Interest on the debt securities are recognized in net interest income. The change in fair value measurement of derivatives subject to fair value hedge accounting is presented in the result on fair value hedge accounting. Interest on derivatives subject to fair value hedge accounting is recognized in net interest income.

The hedged item is expected to generate cash flows in the period until 22 December 2026.

Pekao hedged the variability of cash flows in EUR, that comprised projected cash outflows from an expected future sale transaction, using fx- forward transactions. The FX risk was hedged.

The hedged item consisted of projected cash outflows from an expected future purchase transaction, the level of which depended on the EUR/PLN exchange rate.

The hedging position consisted of a portfolio of fx-forward transactions (composed of a fx-spot transaction and a series of fx-swap transactions), under which the Group purchased EUR in exchange for PLN, to be executed on 11 December 2017 at the agreed exchange rate.

The settlement amount of the hedging transactions adjusted the settlement of the hedged item.

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9. Cash flow hedge for variable-rate PLN deposits

Pekao hedges part of its interest rate risk arising from the variability of cash flows from variable- rate deposits through IRS transactions.

The hedged item are cash flows from a variable- rate deposit portfolio.

The hedging position is the portfolio of IRS transactions (short position at a fixed rate), under which the Group receives variable cash flows and pays fixed flows.

The effective part of the change in fair value measurement of the hedging transactions is recognized in the revaluation reserve. The ineffective part of the change in fair value measurement of the hedging transactions is presented in the result on financial instruments held for trading. The interest on IRS transactions and on the hedged items is recognized in net interest income.

The hedged item is expected to generate cash flows in the period until 22 June 2032.